Canopy Growth (CGC +0.43%) is one of the top pot companies in Canada, and its stock has been soaring of late, currently trading around its 52-week high. It's historically been one of the safer and better-performing cannabis investments, and in the past year, its 45% returns have dwarfed the Horizons Marijuana Life Sciences ETF and its 21% gains.
But it hasn't been a smooth ride for the company. It is in the midst of a transition year and is cutting costs to improve its financials, as investors have been wary of investing in a business that continues to report loss after loss amid minimal sales growth. Is Canopy Growth worth taking a chance on given the recent bullishness in the sector and the changes it's been making of late, or is its valuation simply too rich? Let's take a closer look and find out.
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The company is coming off a record quarter -- but will that trend continue?
On Nov. 9, Canopy Growth released its second-quarter results for the period ending Sept. 30, in which it reported revenue of 135.3 million Canadian dollars -- a new all-time high. It was a 77% improvement from the CA$76.6 million in net sales the company posted in the same period last year. The only segment that didn't generate year-over-year growth was international medicine, where sales of CA$17.5 million were down by 3%.
The problem is that those results may be a little misleading -- the comparisons looked extra favorable thanks to fewer revenue adjustments. In Q2, Canopy incurred adjustments (which include returns and changes to price) of just CA$3.8 million, compared with CA$32.7 million in the prior-year period. And the top line hasn't been rising consistently, either. In the first quarter, sales of CA$110.4 million were only up 2.3% from the previous quarter's CA$107.9 million. And Q4's numbers were down 12.8% from the CA$123.8 million in the quarter before that.
It may be tempting for investors to get caught up in and excited about the company's most recent numbers, but it's important to remember that this hasn't been the norm for Canopy Growth. And that's without even mentioning the problem on the bottom line -- its operating loss of CA$284.3 million in Q2 was higher than the CA$270.8 million loss it incurred in the prior-year period.
The good news is that the company is targeting up to CA$200 million in cost savings, which should get it closer to breakeven. Last month, management announced a halt to operations at some Canadian facilities as part of its restructuring, which affected 220 employees. And while the operational changes will lead to cost savings later on, in the third and fourth quarters, Canopy Growth is expecting pre-tax charges of up to CA$400 million.
For investors, that means that there's still some near-term pain ahead before things potentially get better. And that doesn't solve the company's sales problems, either. There's a lot of uncertainty surrounding Canopy Growth's business right now, and that makes its high valuation a possible obstacle for investors.
Is Canopy Growth stock too expensive?
Since Canopy Growth remains unprofitable, using the price-to-sales (P/S) ratio can be an effective way to compare its valuation against its peers. And based on sales, the stock is in a league of its own when compared against rivals Aphria, Tilray, Aurora Cannabis, and HEXO:
CGC PS Ratio data by YCharts
While there's hope that its P/S multiple will come down as Canopy Growth's business grows, thanks to beverage sales and possible U.S. expansion (once the market is legal federally), that's far from a guarantee. In Q2, the company's cannabis 2.0 products (which include beverages, vape products, and chocolates) totaled just CA$8.7 million -- or 6.4% of net revenue.
The segment isn't a big part of the company's business, and that may be true for awhile. And even if nationwide legalization takes place in the U.S., investors shouldn't assume that Canopy Growth will dominate. While its partnership with Constellation Brands does give it advantages including the potential to expand at a quick pace, it also will have to compete against established multistate operators including Trulieve Cannabis, Curaleaf, and Green Thumb Industries. Either way you look at it, Canopy Growth is going to have a tough road ahead, and that makes it tough to justify buying the stock at its current valuation.
No, Canopy Growth isn't a buy
It's possible that Canopy Growth would become a good buy in a market crash if its stock falls below $20 a share, but today, there's just too much of a disconnect between its sales numbers and its market cap to make it worth investing in. With better-valued stocks out there (like the ones listed earlier), investors shouldn't bother with Canopy Growth. While it used to sit atop the industry as clearly the best cannabis company to invest in, those days are long gone.
